The Four Questions

Irwin M. Stelzer

April 13, 2013 12:00 AM

To understand the American economy, you have to answer four questions. How can it be that unemployment remains high at the same time the number of job vacancies is rising? Will consumers keep buying cars and houses at anything like the current pace despite the recent increase in payroll taxes? How long will Ben Bernanke’s Fed keep printing money to keep interest rates close to zero? Finally, will Washington do what the president asks and get out of the way of an economy “poised for progress”?

The jobs market has analysts scratching their heads. Millions of Americans are dropping out of the work force, driving the labor force participation rate to its lowest level since 1979, which was before women entered the labor force in large numbers. Yet the economy is recovering, and the 3.9 million job vacancies are the highest since 2008. University of Chicago researchers say that many unskilled workers find the level and certainty of unemployment insurance and other benefits more attractive than jobs that would be insecure and low-paid. And worry that the skills of the 40 percent of workers unemployed for more than 26 weeks are no longer relevant to today’s jobs market. Home builders, for example, complain that many unemployed construction workers just don’t have the skills to build today’s high-tech houses. Add to that the possibility that this recovery will create fewer jobs than past recoveries: the Congressional Research Service notes that 97,000 steel workers now produce almost 10 percent more steel than almost 400,000 did in 1980.

We won’t really know whether the recovery will be relatively “jobless” until it picks up steam. That might well be sooner rather than later: There is some prospect that growth will indeed ramp up this year to something like an annual rate of 3 percent if consumers continue to snap up cars and houses.

It is more rather than less likely that they will, although weak retail sales in recent months make that far from certain. Bernanke’s low interest rates are causing share prices to break new records as investors hunt for the yield no longer available from safer investments in a zero-interest rate environment, and low mortgage rates are driving house prices higher. Rising share and house prices produce the so-called “wealth effect”—feeling richer, consumers enter real estate agents’ offices and car showrooms in a cheery frame of mind. With interest rates low, they can afford that bigger house and newer car.

Which brings us to the next question: how long will the Fed continue to pump money into the system? Its stated goal is to run the presses until the unemployment rate drops to about 6.5 percent, but if that drop is due to workers leaving the work force because they are too discouraged to continue looking for jobs the money-printing will continue or, to use the jargon of the central bankers’ trade, quantitative easing will continue—QE3 will not be put into drydock. Until last week’s rather unsettling report that relatively few jobs had been created in March, the discussion focused on when the Fed would wind down its efforts. That topic no longer attracts quite as much attention. The majority view on the Fed’s monetary policy committee is that the jobs market remains so weak that it is premature to consider slowing the presses. Some analysts worry that the Fed will find it difficult to reverse course in time to avoid triggering a serious inflationary spurt, a rise in interest rates and a consequent decline in the value of its massive bond portfolio. But they are in the minority. With Janet Yellin, vice chair of the Fed’s Board of Governors, a supporter of the current loose monetary policy and an odds-on favorite to succeed Bernanke next year, zero interest rates and continued monetary stimulus will remain in place at least through 2014, barring an unforeseen pickup in the jobs market.

It is more difficult to guess whether the president’s efforts to charm the Republican opponents whose motives he has maligned for over four years will result in the “grand bargain” over fiscal policy that has so far eluded the warring politicians. Obama has belatedly put on the table his budget—all 2,500 pages of it. That makes three versions up for consideration: proposals by the president, the Democratic Senate, and the Republican House. The best brief summary is that the Republican version alone brings the budget into balance a decade hence with no increase in taxes, but with politically difficult if not impossible-to-obtain changes in entitlement programs, while the other two proposals rely heavily on tax increases to bring deficit spending down to around 2 percent of GDP in 2013. The distinguishing feature of the Obama version is his agreement to reduce future health care and social security spending by changing the inflation escalator that is applied to those entitlements, a move that affects tax breaks in a way that raises taxes on the middle class. The proposed reduction in the growth rate of entitlements has antagonized many of the president’s lefter supporters: It is designed to induce Republicans to abandon their “no new taxes” pledge in favor of the president’s plan for rather massive tax increases on wealthier Americans, whose tax rates would rise and deductions would fall. As David Malpass, a Treasury official in the Reagan administration points out, Obama wants to increase spending by 60 percent in the next decade. Like the Senate and House budgets, the president’s is based on unrealistic forecasts of growth, interest rates and a host of other variables, but that is par for the budgeting course. And many of Obama’s spending cuts are not quite what they seem: they merely replace the across-the-board cuts already in force due to the sequester.

Although some are predicting an outbreak of bipartisanship, it seems unlikely that Democrats and Republicans can come up with some sort of “grand bargain” to put our fiscal house in order before serious campaigning for the 2014 congressional elections begins. Republicans who acquiesce in tax increases will face serious challenges from Tea Party candidates who want to replace them as the party’s standard bearers, and Democrats who agree to the president’s reduction in the rate of growth of entitlements face a sulky stay-at-home strategy from their left-leaning constituents. As for the president, by making any concession on entitlements contingent on Republican willingness to sign on to a new round of tax-and-spend, he appears less interested in a deal than having a stick with which to beat Republicans in 2014 so that his party can gain control of the House and free him to push through his spending plans.

There you have it: a jobs market that is difficult to understand; a Fed that is likely to keep interest rates low and share and house prices high; a political class trying to choose between a bit of bipartisan deal-making and continued dysfunction.